The Free Market 31, no. 7 (July 2013)
David Stockman discusses his new book, the gold standard, bailouts, and the problems the American economy faces today.
The Free Market: In the book, you oppose Bernanke’s view of the Great Depression, which you point out relies heavily on the views of Milton Friedman.
David Stockman: Bernanke has cultivated this idea that he is a brilliant scholar of The Great Depression, but that’s not true at all. What Bernanke did was basically copy Milton Friedman’s misguided and very damaging theory that the Federal Reserve didn’t expand its balance sheet fast enough by massive open market purchases of government debt during the Great Depression. Bernanke therefore claimed that monetary stringency deepened and lengthened the depression, but in fact interest rates plummeted during the crucial 1930–1933 period: credit contracted due to genuine and widespread insolvencies in the agricultural districts and industrial boom towns, causing bank deposits to shrink as a passive consequence. So Bernanke had cause and effect upside down—a historical error that he replicated with reckless abandon in response to the bursting of the housing and credit bubble in 2008. Friedman’s error about the Great Depression led him, albeit inadvertently, into the deep waters of statism. He claimed to be the tribune of free markets, but in urging Nixon to scrap the Bretton Woods gold standard he inaugurated the present era of fiat central banking. He held that the central banking branch of the state could improve upon the performance of the free market by targeting the correct level of M1 (money supply) and thereby ensure optimum performance of aggregate demand, real GDP, and inflation. That’s Keynesianism through the monetary control dials, and has led to outright monetary central planning under Greenspan, Bernanke, and most of the other central banks of the world today.
TFM: You blame many of our current woes on the movement away from monetary and fiscal discipline decades ago. Yet, why did it take so long for the U.S. economy to get into the deep trouble we’re in today? Have things gotten worse in recent years?
DS: Although central banking does cause moral hazards and lends itself to abuses, there have been periods in which monetary and fiscal discipline have been employed. Fed Chairman William McChesney Martin, for example, really did take the punch bowl away when the party got started because he took monetary discipline seriously. Fiscal discipline under Eisenhower and the gold standard behind Bretton Woods helped put off the day of reckoning for quite a long time. But fiscal discipline went out the window with Lyndon Johnson and Richard Nixon, and the elimination of the weak gold standard behind Bretton Woods certainly didn’t help. The deficit spending of the Reagan years made things even worse.
The Greenspan and Bernanke years then opened the door to the massive abuse of the system we see today. Greenspan took the Federal Reserve, which for years had been run by far more cautious and conservative men, and turned it into a machine for fine-tuning every aspect of the economy. Bernanke has continued this, and taken it even further.
TFM: Among many conservatives and Republicans, it is often claimed that the Reagan years were a victory for free markets and that the 1990s vindicated this strategy. Is this the case?
DS: In the early days of the Reagan years I thought, with many others, that the Reagan Revolution would in fact lead to smaller government. I turned out to be wrong, and politics overwhelmed any commitment Reagan had to making government smaller. The reality was huge growth in the deficit, more government spending, and the laying of the groundwork for the huge debt-based problems we have today.
During the Reagan years and since, the GOP has made peace with tinkering with the economy through the central bank, and joined the Democrats in wanting to gin up so-called aggregate demand and stimulate growth. Dick Cheney declared that deficits don’t matter, and the Republicans abandoned any serious commitment to taking a true hands-off approach to the economy.
In spite of this, the perception remains that the Reagan years were a period of laissez-faire, and this in turn has led to the myth that the fiscal indiscipline of the 1980s led to the boom of the nineties. In reality, the 1990s were a period of monetary profligacy, with a big expansion in the money supply under Greenspan, and a real acceleration in the Fed’s drive to manipulate economic growth and employment from the Fed. This in turn led to the dot-com bubble which burst in 2000–2001.
TFM: We’ve been told that deregulation of the financial sector caused the 2008 crisis, and that a lack of regulation allows the “One Percent” to prosper while the “99 Percent” suffers.
DS: Fundamentally, the financial crisis was a product of the Fed’s repeated blowing up of bubbles, and not of deregulation. Moreover, any suffering inflicted on the 99 Percent by our system doesn’t come from the free market, it comes from the crony capitalism that is now our economic system. The Blackberry Panic of September 2008, in which Washington policy makers led by former Goldman Sachs CEO Hank Paulson, panicked as they saw Wall Street stock prices plummet on their mobile devices, had very little to do with the Main Street economy in the United States. The panic and bailouts that followed were really about protecting the bonuses and incomes of very wealthy and politically well-connected managers at banks and other heavily leveraged businesses that were eventually deemed too big to fail. What followed was a massive transfer of wealth from the taxpayers and middle class savers, in the form of bailouts and zero interest rates on bank deposits imposed by the Fed, to the so-called One Percent. As I show in my book, none of this was necessary to save the larger economy, since the losses that would have taken place as present consumption in order to save for future consumption, the economy quickly will implode and ultimately will slip into a Liquidity Trap in which no one will spend anything.
These fairies can work their magic if (and only if ) one condition exists: factors of production are homogeneous, which means that government spending will enable all lines of production simultaneously. The actual record of the boom-and-bust cycle, however, tells a different story. It seems that the Debt and Inflation Fairies enable booms along certain lines of production (such as housing during the past decade), but as everyone knows, the fairy dust lost its magical powers and the booms collapsed into recessions.
Austrians such as Mises and Rothbard have well understood what Keynesians do not: the structures of production within an economy are heterogeneous and can be distorted by government intervention through inflation and massive borrowing. Far from being creatures that can “save” an economy, the Debt Fairy and the Inflation Fairy are the architects of economic disaster.
Despite Keynesian protestations that the U.S. and European governments are engaged in “austerity,” the twin fairies are active on both continents. The fairy dust they are sprinkling on the economy, however, is more akin to sprinkling ricin on humans. In the end, the good fairies turn into witches.
